The following piece, although focused on Argentina, applies to other populist governments in Latin America. With potential differences in timing and levels, Venezuela, Bolivia, and Ecuador come to my mind.
Fiscal deficit started in December, and might increase. Current account worsened substantially, and it does not look nice. Thus, the exogenously driven twin surplus seems to be mutating to an endogenous twin deficit. Let me elaborate on this.
The government is trying to correct some of the controlled relative prices—but since these prices have been frozen for a long time period, the adjustment impacts on the inflation rate substantially. It remains to be seen if these price increases will be just once and for all or if they will increase the inflation floor. The latter depends on the effects they will have on inflation expectations and relative price re-leveling.1
Private consultants point to an increase in the unemployment rate and the poverty rate as the economy slows down. A recession seems likely. However, even though the latter will partially help taming inflation, the risk of a stag-deflation is on the upside. World demand will decrease during 2009—this will help in keeping commodities’ prices controlled, though.
The above mentioned facts negatively impacts on the government’s revenues. Not only does it reduce export tax collection (price and quantity have been decreasing), but since this tends to contract the economy—especially due to past history of the Kirchner’s little respect for property rights and market economy rules—investment is on the downside risk. Consumption will likely have had its last “spike” during the summer, as agents anticipate their inability for future consumption (on this, see my last post). Therefore, a slowing economy will tend to reduce VAT and other taxes related to the domestic economic activity. It will be difficult for the government to achieve its expected fiscal balance—and the balance is more likely to further worsen as 2009 develops. Three related points: (i) the fiscal balance deteriorated substantially even taking into account the funds provided by the nationalization of the private retirement funds—it would have been much worse in “comparable” (i.e. without these funds) terms (11% & 4.5%, respectively); (ii) this just focuses on the flow of funds as it does not seriously takes into account the accumulated liabilities that paying for these retirees and retirees-to-be include;2 and (iii) in the past the government used to play the following “trick”: the fiscal budget’s tax revenues were artificially underestimated. The excess of revenues over the estimated figure could be discretionally spent—since they were not budgeted in the first place. The more so during an election year. But with a slowing economy the picture looks more like tax revenues will likely be below the estimated in the budget. Red light here?
The government seems inclined to let the currency accommodate to its equilibrium relative price. As of now that looks as if the peso will progressively depreciate—to partially alleviate the worsening of the current account balance. The more so if the government uses it as a mechanism to reduce the real value of its obligations—i.e. to improve the fiscal balance given its inability to reign in public expenditures in a rational manner. This should come as no surprise given the mentioned slowdown, while at the same time the amount of international (i.e. in US$) obligations (principal and interests) due this year and the following one are substantial. However, given the current state of nature and the mentioned macro mismanagement the more likely effect is for the depreciation to pump up the inflation rate (including inflation expectations, which would be worrisome), and thus having strong contractionary effects. Although agricultural producers will partially benefit, the rest of the economy will be worse off—since importing final goods for consumption or parts for production will be affected. (Farmers need not be better off, as the price of their inputs will increase.) Will the old “foreign exchange scarcity” problem return? Finally, the central bank is trying to keep on with its managed depreciation. Add to the latter that farmers are waiting for export taxes to be slashed (to zero?). The longer the wait, the higher the expected depreciation. Is another “Rodrigazo” possible? Not for now, but let’s hope that the “macroeconomist in charge” (NK) will, for a change, act with some rationality.
The Twin surpluses were clearly exogenous. Argentina grew as a consequence of global demand—and despite irresponsible macroeconomic policies and lack of respect for property rights. However, now the king’s clothes are to be seen. The accumulation of the implemented imbalanced macroeconomic policies since 2002 will start showing their teeth (and true nature) now that the world economy sharply slows down. (It is much easier to hide mistakes in a global boom as the one observed during 2002-2008 and with the massive liquidity it brought with it.) Thus, the Twin Deficits will be the economic system “equilibrium” response—its dimensions clearly endogenous.